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Monday, November 5, 2012

Steve Hanke: a Market Monetarist?

This past weekend while traveling, I was able to listen to Steve Hanke on EconTalk with Russ Roberts. Hanke has been out in front of the hyperinflation story in Iran and has been doing some reallyinterestingwork on it. While this is an important discussion, another topic that was brought up in the interview was Hanke's views on the stance of U.S. monetary policy. Hanke argued that monetary policy in the United States has been effectively tight over the past few years. This is evident, he says, by looking to broad monetary aggregates like the M4 divisia, a viewthat I share. Elsewhere, he has argued the Fed should target final nominal sales. With these views, Hanke could almost be confused for being a Market Monetarist. He even calls himself a monetarist in the interview.

There are a few areas, though, in the interview where he appears to differ from Market Monetarists:

(1) He believes that the Fed has been extremely loose with its large expansion of the monetary base that began in late 2008. Market Monetarist disagree and say that the large run-up in the supply of Fed liabilities has been more than offset by a large run-up in the demand for them. Monetary policy is not loose if the Fed fails to check an excess demand for the monetary base. Moreover, monetary policy is not loose if the run-up in the monetary base is not expected to be permanent. If, on the other hand, some part of the increase were expected to be permanent then nominal spending and nominal income should go up today in anticipation of this development. The fact that this has not happened indicates Fed policy has been too tight.

(2) He thinks the Fed has bought up an inordinate share of U.S. treasuries and has therefore kept interest rates too low. Market Monetarist note that the Fed actually holds only about 15% of total marketable treasury securities and therefore is not the main reason for the low treasury yields. In other words, despite the large run up in U.S. public debt, households, their financial intermediaries, and foreigners are more than willing to hold treasuries. Blame them and the weak economy causing them to buy more treasuries for the low interest rates, not the Fed (at least not directly).

(3) He thinks the weak recovery in M4 is the result of onerous bank capital requirements that prevents financial firms from producing many safe assets. There may be some truth here, but this view overlooks the ability of the Fed to catalyze the private creation of more safe assets. Here is how I explained this process before:

[T]he Fed and ECB should create an
environment conducive to monetary asset creation that would support the
return of robust aggregate nominal spending. Since most of the money
assets are created by the credit, maturity, and liquidity transformation
services of financial firms, policymakers should aim to create an
environment conducive to increased financial intermediation. The
easiest way for monetary policy to do this is to raise the expected
growth path of aggregate nominal expenditures. This would raise expected
nominal income growth and the demand for money assets. This, in turn,
would catalyze financial intermediation and lead to the creation of
more money assets. And of course, the way to raise the expected growth
path of aggregate nominal expenditures is to adopt a nominal GDP level
target. It is time for monetary regime change!

I suspect the absent of this action by the Fed is a much bigger factor behind the weak M4 growth than the regulatory burden.

These differences, though, probably overstate the gap between Steve Hanke and Market Monetarists. And maybe his views on these issues are not as different as they seem. In any event, it is good to know that someone with his views is still being heard at the CATO institute.